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Being able to make price projections is first of all important in relation with the risk/reward ratio. You simply cannot calculate the risk/reward ratio if you have no idea what price levels could be reached. On the other hand, knowing different techniques for estimating future price levels will be of great help deciding when to close a trade.
Basic support and resistance will be found at price turning points and windows. More support levels will be found at the level of trendlines and trend channels as well as reaching reaction lines.
Figure 9.1: Basic support and resistance levels.
In figure 9.1 we have a buying signal after a big price move down when the closing price moves above a last downtrend line half of August. In case price would not move up further, there is only one important line and that is the support line. Generally also the initial stop level.
The first target price level is “Resistance_1”, a previous price reversal point. Next we expect some resistance from the 50-day simple moving average. Then follows “Resistance_2”, representing support levels and a window in the previous downtrend, previous support will become resistance. Probably around the same time there is resistance from the medium term downtrend line. Not far away from this level we will find resistance from the 200-day simple moving average.
Finally we have “Resistance_3” an important turning point in the previous downtrend. Close to this level are multiple turning points in the previous downtrend that will show resistance.
Drawing a centerline through the last big downtrend move, we can create some action lines (action-reaction lines will be discussed in the last part of this chapter) through past turning points where these previous downtrends show equal inclinations as the centerline. Projecting parallel lines into the future at the same distance as the action lines creates reaction lines. These reaction lines will also represent price resistance levels.
Figure 9.2: Future price move and the basic resistance levels.
In figure 9.2 you can see how the future price made a big up move. As expected there was a first resistance at the level of “Resistance_1” together with reaching the first reaction line, pushing price back down to the start of the up move. Also the next attack took some time to break that resistance for a move up to the next resistance. There was however support from the 50-day simple moving average.
At the level of “Resistance_2” there are more forces posing resistance. There is of course “Resistance_2” a previous support level in the downtrend now acting as resistance, there is resistance from the downtrend line, there is also resistance from the 200-day simple moving average and some resistance from the second reaction line.
On the further move up there is only slight resistance from the levels “Resistance_3” and “Resistance_4”. Resistance_3”, a previous resistance level in the downtrend turned to a support level for the further uptrend.